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KEYWORDS
Fiscal policy
Taxation
Income tax
History
Tax revenues
Tax reform
Strengthening a fiscal pillar:
the Uruguayan dual income tax
Income distribution
Public expenditures
Uruguay
Alberto Barreix and Jerónimo Roca
T
his paper presents the new system of dual taxation on income that
has been introduced in Uruguay to replace the incomplete schedular system
applying before. The new system strengthens a pillar of taxation defined
as broadly based and capable of generating substantial and stable tax
revenues in a country where 60% of fiscal income is consumed by pension
and interest payments; in addition, the new system redistributes some
2.5% of total household income. The paper describes the development
of the system for taxing income, focusing especially on the four changes
it underwent during the twentieth century. It also compares the different
models of income tax in use today: (i) the traditional synthetic model, based
on the Haig-Simons definition of income; (ii) the flat rate model, derived
from Hall and Rabushka’s consumption tax; (iii) the Nordic dual model,
Alberto Barreix
Senior Fiscal Economist,
Inter-American Development Bank
✒ [email protected]
Jerónimo Roca
Researcher at Complutense
University
✒ [email protected]
which provides for separate taxation of capital income at a fixed rate and
earnings at progressive rates; and (iv) the Uruguayan dual model.
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I
Introduction
Since July 2007, Uruguay has been applying a new
income tax model that is dual in character. This article
describes the new model, explains the need for it in
Uruguay and analyses its redistributive capacity.
The subjects dealt with in the remaining sections
of this article are as follows. Section II presents a brief
historical review of income tax, whose structure was
adapted to the political, economic and social changes
of the twentieth century. 1 Section III analyses the
different models of income tax currently in use: the
traditional synthetic model, based on the broad HaigSimons definition of income; the flat rate model, with
its roots in the Hall-Rabushka consumption (cash
flow) tax; the Nordic dual model, which has separate
taxation of capital income at a fixed rate and earned
income at progressive rates; and, lastly, the “Uruguayan
style” dual model, which takes this central idea of
the Nordic dual model and incorporates elements of
simplicity taken from the flat rate model. Section IV
examines the redistributive capacity of the dual tax
introduced in Uruguay. Section V, lastly, describes
the pillars of taxation and analyses their potential in
Latin America, concluding that there is an urgent need
to renew the design of income tax, and especially
its personal income component, in the interests of
effective collection.
II
A brief historical review
No other tax has undergone the same degree of structural
development as income tax (or more accurately, the
taxation system applying to income) as it has adapted
to changes in international trade and finance, different
levels of economic and institutional development,
political and cultural conditions, technological advances
in the sphere of administration, and different fiscal
policy models. This complex flexibility turned it into
the largest revenue-raiser in history during the period
of greatest revenue growth, the twentieth century.
The authors are honorary members of the Uruguayan Tax Reform
Commission and proposed the design for the “Uruguayan style”
dual income tax in July 2005 in the document “Propuestas para la
reforma tributaria de Uruguay 2005”. They are grateful to Vito Tanzi,
Fernando Velayos, Fernando Díaz Yuberos, Martín Bes, Fernando
Rezende, Ernesto Rezk, Bernal Jiménez, Peter Kalil and Luiz Villela
for their valuable contributions, and to Patricia Abad for her efficient
assistance. This paper does not necessarily represent the views of
the Inter-American Development Bank.
1
Section II summarizes a brief history of income tax included in
Barreix and Roca (2006), annex 1.
Unlike value added tax (vat), an instrument of
efficient and fair trade2 which was pioneered by a
fledgling (continental) European community in the
belief that economic integration would bring peace after
a millennium of conflict, income tax was a result of
war and social strain. Following its official introduction
in Great Britain in 1799, for almost two centuries this
tax was used as an extraordinary income source to
defray the costs of war or alleviate social tensions,
either directly as an instrument of income redistribution
or indirectly for the financing of public expenditure
at times of social upheaval. Even the most recent
architectures of the late twentieth century, the dual
and flat taxes, were motivated by the need to fight for
savings and investment in an increasingly competitive
globalized economy.
2
The idea of vat can be traced to the papers of the German trader
von Seimans in the 1920s and was applied for the first time in
France, in the early post-war years. In the version of it where
final consumption is used as the tax base following the destination
principle, it is possible to avoid taxing investment, exporting taxes
or concealing subsidies.
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The other great difference from vat, that other
revenue-raising mainstay of our times, concerns
simplicity of structure and objectives. In its more
than seven decades of development, vat has had to
be simplified3 on a consumption and credit method
basis, and while there are variations in rates and tax
bases, the primary objective is still to raise revenue
on an essentially neutral basis. Today more than ever,
on the other hand, income tax types and rates present
the most varied structures, ranging from the most
complex comprehensive models to the simplest flat
rate systems, with a similar diversity of tax breaks and
incentives. These dissimilar formats reflect the unstable
equilibrium between the goals of adequacy, efficiency
and equity served by this tax.
It is for this reason that income tax was abolished
and reinstated a number of times in various forms
and in different countries during the nineteenth and
twentieth centuries. Continuous wars to consolidate
nation-States and expand empires, the pressure of
political movements opposed to industrial capitalism,
and social and technological change made it necessary
to consolidate and renew the tax. During the twentieth
century, therefore, income tax, which was the main
revenue-raising resource, passed through four major
reformulations.
The first was the “technical” introduction of the
tax (with the progressive character and administrative
form we are familiar with today) in the British budget
of 1909 and in the United States federal Income Tax
Act of June 1913. The second transformation was
the “massification” of the tax during the Roosevelt
administration, around the time of the Second World
War, in parallel with the spread of democratic
participation and public action through social welfare
programmes. Sustained by the success of the New
Deal and the reconstruction of Western Europe, and
by a skewed interpretation of Keynesianism, public
spending growth created a huge demand for fiscal
resources. This pressure led to a spiral of increases
in income tax rates, counteracted by a proliferation
of exemptions and special treatment that distorted the
structure of the tax. The third phase was a reaction, the
3
It is fair to say that vat presents problems of (i) revenue reversal,
as in the case of financial services or sales of second-hand items;
(ii) administration in sectors such as real estate, agriculture and
microenterprise; (iii) distribution to lower levels of government,
given that it is by nature a national tax; and (iv) regressiveness, as
it is a tax on consumption.
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“counter-reform” of the Thatcher administration, and
to an even greater degree the Reagan administration,
in the 1980s, which restored the original composition
of the tax by sharply reducing rates and expanding the
tax base, without significantly affecting either the tax
take or the factor burden. In the fourth reformulation
of the early 1990s, lastly, innovations came “from the
cold”: the dual model of the Nordic countries and the
flat tax of the new market economies (countries of the
former Soviet bloc) adapted income tax to cope with
international competition for saving and investment
while maintaining (in part) its progressive character.
1.The four adaptive mutations of income tax
in the twentieth century
(a) Conflicts of region, class and power: the birth
of the progressive, personalized income tax
In June 1913, when 42 states ratified the Sixteenth
Amendment to the Constitution allowing the United
States Congress to tax income at the federal level,
the relationship between classes, between regions and
between centres of authority in the country shifted. The
approval of income tax marked the end of the “republican
system” of taxation built up by the party Lincoln had
founded. This system was based on protectionist
customs tariffs favouring the industrialization of the
country’s north at the expense of the south, which was
where raw materials were produced. The south did not
accept this, but was defeated in the Civil War.
As for class, tariffs represented a subsidy to the
great industrial enterprises and a charge on farmers and
consumers. In addition, large companies had integrated
vertically and made technological advances, tapping
a larger market than their European competitors’ and
an unregulated labour supply fed by large flows of
migrants; all this added up to copious profits (Brownlee,
2004; Steuerle, 2004). The “republican system” of
taxation was a precursor of the import substitution
model, except that the United States succeeded in
consolidating a large economic space (market). Latin
America, on the other hand, divided into numerous very
different jurisdictions, has not succeeded in integrating
even to the modest extent of creating subregional free
trade areas.
On the other side of the Atlantic, industrialization
brought greater democratization (influence of the House
of Commons) within the peculiar British political
system, leading to the overwhelming Liberal victory
of 1906. Under the influence of David Lloyd George,
a social reformer, old-age pensions were approved in
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1908, and the famous 1911 budget brought in sickness
and unemployment insurance of a Bismarckian hue.
Politically, the influence of the House of Lords was
reduced when the Liberals overcame its opposition to
the income tax in the “people’s budget” of 1909.
Technically, income tax was driven throughout the
twentieth century by the emergence of tax instruments
(Tanzi, 2006) based on advances in other disciplines such
as bookkeeping and administration. For example, advances
with bookkeeping made it possible to record company
revenue flows more accurately, and the appearance of
large enterprises meant that deductions could be made
from the incomes of a growing class of wage earners,
reducing administration and compliance costs.
(b) The new role of the State, the predominance of
fiscal policy and the large-scale application of
income tax
President Franklin D. Roosevelt not only revived
his country after the greatest crisis capitalism had
experienced (the Great Depression) and set in train the
military victory over corporative dictatorships around
the world, but also expanded the goals and framework of
State action, expressing them in a new social contract,
the New Deal. One result was an expanded role for the
State in stabilizing the economy and thus in running
certain activities, and in providing benefits through a
more comprehensive social security system.4 To these
two drivers of public spending growth was added the
military effort of the Second World War. To finance all
this, income tax was applied on a massive scale.
Technically, Simons’ definition of economic
income (consumption plus change in net wealth)
prevailed from the 1930s onward, and this made it
possible to establish progressivity with redistributive
effects and horizontal equity.
Continually rising rates, accompanied by a
shrinking of the tax base due to the introduction of
tax breaks and loopholes (whose purpose was to avoid
possible negative effects on saving, the labour supply and
venture capital investment), were characteristic of the
federal income tax during the Roosevelt administration
and were to dominate the tax landscape of the developed
Western economies for the next 40 years.
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In summary, the (reactive) increase in fiscal revenues
was once again a consequence of growing demand for
public infrastructure and social services stemming from
the political maturation of the industrial revolution, and
of the war effort. Between 1920 and 1960, on average,
fiscal pressure more than doubled in the developed
countries, total public spending grew by over 50%
and social spending trebled (table 1). And income tax
responded once again, growing almost out of recognition
but reaffirming its capacity to adapt to social changes and
take advantage of technological innovation.
(c) The “counter-reform”: a return to lower rates
and a broader base
From the immediate post-war period to the late
1970s, State activity expanded unceasingly with
reconstruction in Europe and the “Great Society” 5
project in the United States. Sustained by an exaggerated
version of Keynesianism and the early growth of the
planned economies, it took fiscal pressure to levels of
close to 50% of gross domestic product (gdp) and upper
marginal income tax rates to 90%. The reform of this
tax in the United States in 1986, like the earlier reforms
by the Thatcher administration in the United Kingdom,
broadened tax bases and reduced tax expenditure,
particularly “corporate welfare” for large enterprises,
while at the same time lowering rates in what constituted
a return of income tax to its roots.
One of the most important reasons for reducing very
high tax rates in developed countries (averaging over
70% in the 1970s) was to sustain saving and investment
in an increasingly open world. These countries had
been liberalizing trade and finance for over a quarter
of a century. Average customs tariffs were below 5%
and trade diversion had also diminished, although there
were still some non-tariff barriers affecting agricultural
products in particular. Lower tariffs, especially for
manufactures, led to a gradual deindustrialization of the
developed countries, while at the same time international
competition was increasing.
It is important to realize that trade and financial
liberalization was also influenced by the need to
support the new dynamic sectors (“new economy”).
With liberalized trade and less customs protection,
the profitability of the manufacturing sector declined.
Broad-based income taxes with low rates favoured
4
The Roosevelt administration promoted the idea of State protection
to provide individuals with at least a minimum level of welfare (in
respect of poverty, unemployment and pensions) throughout their
lives, adding functions to the Hamiltonian version of government
that prevailed in the United States.
5
It aimed for an end to poverty and social injustice (Lyndon Johnson)
to build on Roosevelt’s mass social security programme.
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table 1
Developed countries: Government revenues and total and social public spending,a
around 1870 and selected years of the twentieth century
(Percentages of gross domestic product)
Government revenue
Total public spending
Circa
1870
1920
1960
1996
Circa
1870 1920
1960 1996
Australia
17.8
Austriab
…
Belgiumb c 11.6
Canadab
4.1
France
15.3
Germanyb
1.4
Hollandb c
...
Ireland
9.6
Italy
12.5
Japan
9.5
Norway
4.3
Spainb c 9.4
Swedenb
9.5
Switzerlandb
…
United Kingdom 8.7
United States
7.4
Average
9.3
Growth %
19.4
9.0
17.0
16.6
17.9
8.6
11.8
23.2
24.2
…
11.5
5.8
7.2
3.8
20.1
12.4
13.9
49%
24.4
37.9
30.3
26.0
37.3
35.2
33.9
27.5
24.8
18.8
32.4
18.7
32.5
23.3
29.9
27.6
28.8
107%
35.0
18.3
47.8
10.5
49.8
…
42.7
…
50.3
12.6
45.3
10.0
47.3
9.1
36.5
...
46.2
13.7
31.7
8.8
51.4
5.9
39.0
...
62.1
5.7
36.4
16.5
37.2
9.4
31.6
7.3
43.1
10.7
50%
19.3
14.7
22.1
16.7
27.6
25.0
13.5
18.8
30.1
14.8
16.0
8.3
10.9
17.0
26.2
12.1
18.3
72%
21.2
35.7
30.3
28.6
34.6
32.4
33.7
28.0
30.1
17.5
29.9
18.8
31.0
17.2
32.2
27.0
28.0
53%
Public social spending
Circa
1880
35.9
1.1
51.6
...
52.9
1.3
44.7
1.3
55.0
1.3
49.1
2.0
49.3
1.5
42.0
…
52.7
0.6
35.9
0.3
49.2
1.2
43.7
0.3
64.2
2.0
39.4
2.8
43.0
1.2
32.4
1.1
46.3
1.3
65%
1920
1960
1995
2.8
3.7
2.6
1.3
2.4
7.5
2.5
7.0
1.7
2.3
3.9
1.7
3.6
2.2
6.2
2.2
3.4
160%
7.4
15.9
13.1
9.1
13.4
18.1
11.7
8.7
13.1
4.1
7.8
13.9
10.8
4.9
10.2
7.3
10.6
216%
14.8
21.4
27.1
18.1
26.9
24.9
25.7
18.3
23.7
12.3
27.5
19.0
33.1
18.9
22.5
13.7
21.7
105%
Source: Tanzi and Schuknecht (2000) and Lindert (2004).
a
Includes poverty and unemployment relief, education, pensions, health care and housing subsidies.
The figures for Austria, Belgium, Canada, Germany, Holland (later the Netherlands), Spain, Sweden and Switzerland are for central
government only up to 1937.
c
The figures for Belgium, Holland (later the Netherlands) and Spain are for central government only up to 1920.
b
risk-taking in the new businesses: finance, knowledge
technology and entertainment. Thus, investment
opportunities increased for higher-income groups and
bureaucracies became more active, winning acceptance
for the abolition of particular incentives (privileges).
The rate reductions applied in the 1980s in these
two leading, harmonized and growing markets led to
a realignment of income tax around the world in an
increasingly intertwined global economy. Thus, in one
decade the average reduction in top marginal personal
income tax rates was almost 34%, while the reduction
for corporation tax was almost 28%. Yet the fiscal yield
and the tax burden on factors of production remained
virtually unchanged.6
6
Boscá, García and Taguas (2005) analysed average effective tax
rates for capital and labour using a database for 21 countries of the
Organisation for Economic Co-operation and Development (oecd)
in the 1965-2001 period. What the analysis shows is that the tax
In summary, the old principle of progressive
taxation through income tax was asserted without
loss of revenue during the Reagan administration,
harmonizing with the revolt against the enlargement of
the public sector.7 Although the growth of government
was checked during the 1980s, however, fiscal pressure
increased by 50% between 1960 and the end of the
twentieth century, while public social spending doubled
(table 1).
burden in the United States has risen since 1986 for both capital and
labour, although the tax burden on labour grew by 13% more; in
the United Kingdom, meanwhile, both rates fell up to 1997. In the
other oecd countries, tax burdens on factors of production changed
only very moderately. Data from the oecd and European Union (15
countries) also reveal a slight increase in the income tax take: between
1979/1980 and 1989/1990, it rose from 12.48% and 12.51% of gdp,
respectively, to 13.1% and 13.8%.
7
The richest quintile in the United States paid an effective rate of
27.6% in 1980, falling to 25.5% in 1990, while its share of pre-tax
income rose by 4.4% in the same period (from 31.7% to 36.1%).
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(d) The innovation “from the cold”:
competitiveness without loss of equity
In the last decade of the twentieth century, for
reasons of efficiency and administrative convenience,
the Nordic economies, which are among the world’s
most competitive, introduced a dual system of taxation
giving different treatment to income from capital (both
saving and investment), which has become increasingly
mobile. The Nordic countries formalized “dual income
tax”, but it is only fair to acknowledge, as will be seen,
that most tax laws had already introduced some degree
of duality, making the treatment of capital gains and
interest more favourable.
In the new market economies, meanwhile, income
tax was turned into a single rate (flat) tax for income
of all kinds, with a high exemption threshold that
conferred vertical equity upon the tax while releasing a
large percentage of the population from the obligation
of paying it. Combined with the small number of
permissible deductions, this considerably facilitated the
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work of newly created tax administrations. The flat tax
was introduced in Estonia in 1994, but became more
visible when the Russian Federation adopted it in 2001.
Lithuania and Latvia followed their Baltic neighbour in
the first wave of this tax and after 2004 it also spread
to Slovakia, Georgia, Rumania and Ukraine.8
For the first time, change has been led not by the
major powers but by small economies whose sights are
set on international competitiveness rather than on some
external or internal political enemy. The purpose of
these changes is to maintain the progressivity of the tax
and its ability to raise funds for the financing of social
policies (especially growing pension spending) and to
simplify compliance and administrative oversight (given
the weakness of institutions and the disadvantages they
work under by comparison with large multinational
and regional corporations, since effective cooperation
between jurisdictions is lacking). This latest development
in the structure of the tax, in its dual and flat forms, will
be analysed in greater detail in the following section.
III
Different models of income tax
In the world generally, and in Latin America in
particular, a very wide range of income tax models
coexist for all three components of the tax: personal,
corporate and international. The range runs from
Mexico with its Haig-Simons type income tax system
that includes worldwide income, sophisticated taxation
of inflation-adjusted capital income and full integration
between personal income tax and corporation tax, to
Paraguay with an almost flat tax presenting a rate of
10% on personal incomes (the same as the general
vat rate) and 20% on corporate income of Paraguayan
origin.
There now follows a comparative analysis of
the four income tax models in use: the synthetic (or
comprehensive) model, the flat rate model, the Nordic
dual model and, lastly, the Uruguayan dual model.
to income brackets. The tax follows the Haig-Simons
broad definition of income: consumption plus change
in wealth over a given period.
The theoretical advantages of this model are clear
although, as will be seen later, serious doubt has been
cast over them in practice. Among these advantages
are: (i) including “all” income (Haig-Simons broad
definition), giving equal treatment to income from
employment and capital and allowing deductions in
the tax base and reductions in the tax amount to be
paid facilitates personalization of the tax and serves
the interests of horizontal equity (i.e., taxpayers with
the same payment capacity actually do pay the same
amount) and (ii) conferring progressivity on the tax by
means of progressive marginal rates (vertical equity),
assuming the tax authority collects it effectively, even
at high marginal rates.
1.Synthetic income tax
This income tax structure, also known as integrated tax,
combines (integrates) all the incomes of the taxpayer
(the individual or family) and taxes them in accordance
with a structure of progressive marginal rates applied
8
Flat rates vary from country to country, ranging from 12% to
33% for personal income tax (with different personal deductions
for the taxpayer and per dependent) and from 16% to 37% for
corporation tax.
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As we have said, though, the facts have cast doubt
on these virtues of synthetic personal income tax. For
example, its application has usually been associated
with “pick and choose” deductions whose purpose
is to encourage particular forms of behaviour. In
other words, the government indicates what types of
activities are to be favoured,9 in accordance with its
policy decisions, and the individual chooses. Leaving
aside the issue of whether it is right for the tax system
to be used to encourage particular types of behaviour
among economic agents, it is clear that a larger
number of deductions means a smaller tax base, so
that marginal rates have to be higher if revenue loss
is to be avoided.
If account is also taken of the opportunities that
financial liberalization provides for capital, the most
mobile factor, then the stage is set for an outflow of
savings. When financial capital (savings) is taxed at
very high marginal rates (the marginal rate is what
influences the decision to save), those receiving the
income from it, who belong to the wealthiest strata, tend
to shift savings to jurisdictions with low or zero taxes.
This destroys both horizontal and vertical equity.10 As
will be seen, the dual income tax model of the Nordic
countries can be viewed as a response to this flight of
savings associated with personal income tax.
This problem is compounded by the administrative
complexity of synthetic personal income tax. For
example:
(i) the welter of deductions generates high
administration and/or compliance costs;
(ii) to prevent the unintended incentives of traditional
taxation (double taxation of dividends, first at the
corporate and then at the personal level), different
mechanisms have been sought to integrate
corporation tax and personal income tax, which
creates administrative difficulties; and
(iii) correcting excessive progressivity when incomes
are irregular also creates difficulties in determining
tax periods.
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2.The response to the administrative
complexity of synthetic taxation: the flat tax
Given the administrative complexity of synthetic
personal income tax, and to correct the scope for
arbitrage created by the difference between corporate
and personal income tax rates, Hall and Rabushka (1983
and 1995) proposed a combination of two taxes with
the same rate:
(i) a tax on the real financial flows of companies
(cash flow type), i.e., on sales (including exports)
minus wages, inputs and investment (which can be
deducted in full at the time it is carried out), and
(ii) a tax on wages, with a non-taxable personal
allowance to provide a degree of progressivity
despite the tax being levied at a flat rate.
Saving is not tax-deductible at the time it is
carried out, nor is the yield on it taxed subsequently.
That is, there is no tax on interest, dividends or capital
gains, and companies cannot deduct interest paid.11 To
put it more clearly, banks do not pay corporation tax
under this system. It is easy to show that, from a life
cycle perspective, this design taxes consumption.12
Furthermore, it acts as a consumption base vat
working on the origin principle and calculated by the
subtraction method.
The only major similarity between the flat tax
introduced in some countries (Estonia, Lithuania,
Latvia, Russia, Serbia, Ukraine, Slovakia and Rumania)
and Hall and Rabushka’s system is the existence of a flat
tax on wages. The main differences, meanwhile, are in
(i) the method of establishing the tax-exempt allowance;
(ii) the fact that some have taxed capital income and
others have not; and (iii) the fact that they have all kept
the traditional corporation tax, and not necessarily at
the same rate as the tax on earned income.
Although a long way from Hall and Rabushka’s
proposal, the flat tax applied does simplify administration.
For example: (i) the application of withholding tax is
more straightforward; (ii) the problem referred to earlier
of excessive progressivity when incomes are irregular
is done away with; (iii) there are fewer incentives
to shift income between related taxpayers (spouses),
9
In our view, there are basically two types of deductions (or credits):
those that aim to mitigate the effect of the income tax on saving,
and those that give privileged treatment to activities believed to have
positive externalities (health care, education, etc.), although targeted
spending is acknowledged to be the most efficient option.
10
The special deduction for wage-paying employment applied
in many countries is a form of compensation and an implicit
acknowledgement of this inequity.
11
Interest is a transfer that does not generate value added if it takes
place between residents. When it is not deductible, taxation ceases to
be a consideration in assessing the optimum financial mix.
12
A tax on wages over the whole life cycle, assuming no stock of
savings remains at the end, is equivalent to a consumption tax at
present value. If savings do remain, this observation holds true if
an inheritance tax is added.
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although they do not disappear completely owing to
the existence of the personal tax allowance; and lastly
(iv) if the corporation tax rate is made the same as the
rate for earned income (as in the Slovak Republic and
Rumania), there is no longer an incentive for people
to set up companies to reduce the tax burden on their
economic activities.
As Keen, Kim and Varsano (2006) point out, the
greater simplicity of income tax in these countries has
nothing to do with its flat rate structure. What they have
done is to set a personal allowance level that is high
enough to leave a large percentage of the population
outside the tax net, and allow only a limited number
of deductions.
The main problem with the flat tax is that the rate
needed to maintain the pre-reform tax take is too high for
capital income. As a result, this flat tax, like the synthetic
tax, displaces saving (i.e., causes capital flight).
3.The answer to capital flight: “dualization”
of the synthetic tax and the dual tax of the
Nordic countries
If Hall and Rabushka’s proposal can be seen as a
response to the administrative complexity of synthetic
personal income tax, the dual system of income tax
applied by the Nordic countries can be seen as a
response to the capital flight also associated with the
synthetic tax. Strictly speaking, some degree of duality
began to be applied in the treatment of capital gains
and interest during the 1980s as a first response to
this mobility of savings. In the case of capital gains,
most countries established a differential rate below the
top marginal rate of personal income tax. The United
States is a typical case: capital gains made over a period
greater than a year are taxed at a flat rate of 15%. As
for interest, developing countries began to establish a
schedular system with lower rates. This was done in
Latin America by Argentina, Brazil, Costa Rica and
Nicaragua, for example.
In the Nordic countries (Denmark, Finland,
Norway and Sweden), the flight of savings was
compounded by the problem that their integrated
systems had much higher marginal rates than those of
other countries (up to 73% in Denmark and Sweden),
while at the same time the tax base was narrow because
of special treatment and exemptions for certain types of
capital income and full deduction of interest payments
(mortgage interest in particular) at these high marginal
rates. Special treatment for capital income was part of
a (disorderly) attempt to make their tax systems more
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attractive and prevent the flight of savings because
of a lack of cooperation between tax administrations.
But the integrated system thus designed contained
strong incentives for avoidance through tax planning,
produced a negative yield on capital income and was
more progressive in theory than in practice (Picos
Sánchez, 2003).
Consequently, between 1987 and 1993 the Nordic
countries formalized the dual income tax. Basically,
this gives separate tax treatment to earned income
(taxed at progressive rates) and capital income (taxed at
proportional rates), whether from business operations or
passive investment. As figure 1 shows, the Nordic dual
tax “anchors” the rate applicable to corporate income
and capital income (around 30%), which in turn is the
lower rate for the tax on earned income, this being taxed
progressively up to rates of around 50%.
With this design there is no scope for arbitrage,
either by abusing capital income to obtain business
income (both taxed at the same rate) or by passing off
business income as earned income (paying oneself a
salary instead of collecting dividends). Nonetheless,
physical persons with mixed incomes (own-account
workers, sole proprietors and partnerships) do have
a strong incentive to pass off their earned income
as business income. Many experts regard this as the
Achilles heel of the Nordic dual system.
Something similar is true of Chile, where business
income is subject to a system of taxation based on
withdrawals: retained profits are taxed at 17%, while
distributed profits, which are included in the synthetic
personal income tax along with the taxpayer’s other
income, may be subject to the top marginal rate of 40%.
This large difference creates a strong incentive to retain
profits. According to data from the Chilean Internal
Revenue Service (sii), there are more than 30,000
investment companies created exclusively to administer
retained profits, and over 50% of undistributed profits
accumulate in companies of this type. This “deferral
cost” (more crudely put, personal income disguised
as business income) is over 2% of gdp, while the tax
take from personal income tax is somewhat below that
figure (sii, 2006). That so much tax should be foregone
is surprising considering that tax expenditure is only
0.6% of gdp for corporation tax and 0.9% for vat,
which collects 8.5% of gdp.
4.The Uruguayan dual income tax
Contrary to what is usually claimed, Uruguay already
had a personal income tax before the tax reform that
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Figure 1
Nordic dual income tax
50%
Employment
income, top rate
Arbitrage: own-account
employment income as
business income
30%
Business
income
Pure capital
income
Employment
income, bottom rate
Source: Prepared by the authors.
came into force in July 2007; more precisely, it had
an incomplete schedular type income tax system
whereby different taxes were applied to particular types
of income at different rates, leaving other incomes
unaffected. For example, the personal receipts tax
(impuesto a las retribuciones personales—irp) affected
wages, pensions and unemployment insurance; the
commissions tax (impuesto a las comisiones) affected
a large number of non-professional service providers
(customs agents, currency dealers, salespeople, etc.);
the income of sole traders was subject to corporation
tax. However, other income, such as that from
professional services, interest, rent and capital gains,
was not taxed.
These taxes on income were supplemented by a
number of lesser taxes that were inefficient (causing
distortions) and/or expensive to administer and comply
with. Many of them came out of the continual “fiscal
reforms” of the 1990s —actually minor adjustments
that worsened the quality of the tax system. In the 13
years from 1990 to 2002, 13 taxes were introduced, or
exactly one a year.13 The introduction of the dual tax
meant that most of them could be repealed.
13
To name a few: social security financing contribution tax (cofis, a
kind of wholesalers’ vat), bank asset tax (imaba), financial system
oversight tax (icosifi), credit card tax, sportsmen’s transfer tax,
forced sales tax, lottery tax, tax on the sale of movable property
by public auction.
The need to resolve the design problems of the
incomplete schedular income tax system was one of
the reasons for overhauling it. These problems included
the following:
(i) the system was not comprehensive, i.e., did not
cover all income. This was a clear violation of the
principle of horizontal equity (same treatment for
taxpayers with the same ability to pay);
(ii) it did not attain vertical equity, since most earned
incomes, including income from businesses, were
taxed at high rates, while most types of capital
income, going predominantly to the higher-income
strata, were exempt.
(iii) because the system consisted of an assortment
of taxes with different bases and different rates,
it created numerous opportunities for arbitrage,
one example being back-to-back loans whereby
business owners lent money (interest exempt)
through a third person to their own company
(interest deductible). This is reflected in the ratio
between corporate income and assets in 19931997: while this ratio averaged about 3.5% for
industry and services, the average for banks was
0.08%, i.e., less than 1‰ (Barreix, 2003).
The new Uruguayan dual income tax takes from
the Nordic dual system the core idea of taxing earned
income separately (at progressive rates) from capital
income (proportional rate). In other words, it establishes
a lower tax rate for capital yields (interest, dividends
and profits, rents, capital gains) which is the same as
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Figure 2
Uruguayan dual income tax
25%
Business
income
Employment
income, top rate
Pure capital
income
Employment
income, bottom rate
Arbitrage:
business income
as capital income
12%
10%
Source: Prepared by the authors.
the bottom marginal rate for earned income. This rate
is the “anchor” of the system, the lowest rate at which
income begins to be taxed.14 In turn, the top marginal
rate on earned income is the same as the rate for (net)
business income.
The political debate in Uruguay led to the decision
that the single all-in tax rate15 on capital incomes would
be 12%, and would thus not be the same as the 10%
bottom marginal rate on earned income (figure 2). Taxes
on earned incomes range up to 25%, which is also the
rate for business income.
The Uruguayan dual rate, therefore, limits
the scope for arbitrage offered by the Nordic dual
system, to the point where physical persons providing
professional services or obtaining business type
incomes are free to choose whether to pay corporation
tax or personal income tax. The system is designed so
that, for example, self-employed taxpayers can choose
between paying as businesses at a nominal rate of
25% on net income (after deduction of all admissible
14
It is recognized that capital gains and royalties are not gross
income. Accordingly, Barreix and Roca (2005) proposed that
they should be taxed at a higher rate (15%), but administrative
considerations, particularly as regards international income, led to a
flat rate being adopted. It was also proposed that technical assistance
from non-residents and dividends paid abroad should likewise be
taxed at this rate.
15
The deduction at source is final and releases the taxpayer from
any obligation of declaration or identification.
business expenses) or paying as physical persons
under the system of earned income brackets, whose
top marginal rate is also 25%; in this latter case, they
cannot discount business expenses but only personal
expenses (social security contributions, payments for
their children’s health care and a set percentage of 30%
for expenses). Self-employed taxpayers who are “large”
(employing professionals and having a substantial
infrastructure, for example) will undoubtedly choose
to pay tax as corporations to be able to deduct their
expenses. Those who are “small” may be better off
paying as physical persons, something that makes
economic sense given that labour is bound to be the
main factor of production in their work (and the system
does not set out to punish them by taxing them as
though they were acting predominantly as employers).
This is not arbitrage; for arbitrage to exist, there has
to be a dominant strategy whereby the taxpayer always
gains by dissimulation.
Meanwhile, the possibility of arbitrage between
business income and gross capital income is resolved
by the customary rules of corporation tax. 16 The
solution the reform opted for to prevent arbitrage
when interest (taxed at 12%) is deducted to calculate
16
By applying the payment credit method to retained capital income,
together with thin capitalization rules for interest and/or deduction
limits for capital income when business income is calculated.
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business income (taxed at 25%) was to require that the
deduction matched the proportion between the all-in
withholding tax rate applied to capital and the business
income rate (i.e., 12/25).
Lastly, the Uruguayan dual system follows the
flat tax in setting a tax allowance that leaves a large
proportion of the population (60%) outside the tax net
and in allowing only a small number of deductions,
thereby facilitating administration and preventing the
erosion of the tax base (and the lobbying) that are
a feature of the synthetic model, especially in Latin
America.17
The reform of personal income tax in Spain,
which was formulated in 2006 and came into force
on 1 January 2007, implemented a dual model closer
to the “Uruguayan style” dual tax than to the Nordic
dual tax. The lowest rate at which income begins to be
taxed is for capital income (18%), and is close to the
bottom marginal rate for earned income (24%). The top
marginal rate on earned income, meanwhile, is 43%;
given the deductions allowed and the tax on dividends,
this rate discourages physical persons from setting up
as companies (taxed at 30%) to conduct their economic
activities. Regarding the possible abuse of interest in
obtaining business income, reliance is placed on thin
capitalization rules.
At this point in the analysis of taxation models,
it is worth asking why a dual system was chosen
for Uruguay. The answer is that the decision was
influenced by reasons of an administrative nature and
by considerations of efficiency.
Among the administrative reasons are the
following: first, at a time when mercosur is still
incomplete, Uruguay is obliged to follow a “small
country” strategy that aims to capture external savings,
by contrast with the “big country” strategy followed
by Argentina and Brazil, whose aim is rather to secure
foreign direct investment. This strategy does not
permit high marginal rates like those of the traditional
synthetic model. Similarly, the flat rate necessary
to generate the same amount of income tax revenue
17
In the tax base constituted by earned income, the personal tax
allowance is approximately 70% of per capita gdp, i.e., more than
twice the value of the basket used to calculate the absolute poverty
line. There is no provision for a tax-exempt allowance in the capital
income tax base and nor, for reasons of bank secrecy, is offsetting of
capital income allowed (other than rents). The deductions authorized
in the earned income tax base are contributions to pension plans (both
compulsory and voluntary) and health expenditure by the taxpayer
and the taxpayer’s children while minors, up to a certain limit.
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131
(from companies, individuals and non-residents) as
the Uruguayan dual tax is expected to yield would be
around 19%; for capital income this rate would be too
high, encouraging the flight of savings.
Second, the low quality of tax administration in
Uruguay means that the new income tax system has
to be straightforward. The model approved is easy to
comply with and oversee because:
(i) capital income, whether received by residents or
non-residents, is taxed at a flat all-in withholding
rate;
(ii) 60% of the total population are left outside the
income tax net, so that a fifth of the population
that was affected by the personal receipts tax (irp),
now abolished, will be unaffected by the dual tax;
in addition, 80% of this tax will be paid by the
wealthiest 20% of the population;
(iii) it allows few deductions (just three: social security
contributions, health insurance contributions and
deductions per child or dependent), which are easy
to calculate;
(iv) it prevents tax arbitrage between taxpayers’
different income types and/or legal status, thereby
reducing incentives for evasion or tax-driven
changes in saving portfolios; and
(v) it raises more revenue than the incomplete
schedular tax, making it possible to do away with
inefficient taxes (imaba, cofis and others) and
thus simplifying the system.
Third, the proposed design allows Uruguay to
retain bank (tax) secrecy without being regarded as
a tax haven.
It should be stated here that we are not supporters
of bank secrecy. It creates information asymmetry,
leading in turn to market failure (Stiglitz and Grossman,
1980), by depriving partner countries of the ability to
apply taxes or combat fiscal fraud and thereby finance
part of their public spending. In essence, this means
exporting a tax base (Tanzi, 2001). However, we
believe that the current situation in mercosur forces
Uruguay to use tax (bank) secrecy as a negotiating
tool. The fact is that as long as mercosur is not
perceived as a consolidated customs union (it does not
have a common trade policy, it lacks a serious dispute
resolution system and customs controls are abused),
investment will tend to go to the largest market, chiefly
Brazil and then Argentina, and this will be reinforced
by the incentives offered by these countries. For this
reason, Uruguay’s share of foreign direct investment
(about 3%) is significantly lower than its share of the
bloc’s gdp (about 5%).
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The main criterion used by the Organisation for
Economic Co-operation and Development to define tax
havens is that they impose low or no taxes on saving
income (oecd, 2005). By taxing capital income at
substantial all-in rates, the Uruguayan dual tax makes it
impossible for Uruguay to be regarded as a tax haven,
since it does not meet this criterion. This provides a
reaffirmation of legal security, while the all-in tax
allows the depositor’s identity to remain confidential.
The result is to make the country even more attractive
for domestic or external savers, who take decisions by
assessing the trade-off between returns and security.
Regarding considerations of efficiency, Feldstein
(2006) argues that taxing capital income at high rates
gives rise to two types of problems:
(i) the loss of efficiency associated with a tax on
saving should be measured not by the reduction
in its current level but by the drop in the future
consumption that today’s saving will be able to
buy, meaning that it is substantially greater than
the loss usually estimated; and
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(ii) high taxes on capital income lead to inefficiencies
in the allocation of capital. For example, a
high rate of tax on dividends discourages their
distribution (lock-in effect), with the following
consequences: first, it results in a loss of efficiency
in investment choices; second, it is a disincentive
to discipline for managers, who have privileged
access to internal financing; third, it can even
lead to a lower tax take than would be obtained
by taxing investment (or consumption).18
As pointed out earlier, Chile is a case study
in this respect. The strong incentive represented by
the difference between the rates on undistributed
profits (17%) and distributed profits (up to 40%) has
led to a situation, according to estimates by the tax
administration (sii), in which retained profits total 2%
of gdp (sii, 2006). Furthermore, Cantallopts, Jorrat and
Scherman (2007) state that retained profits are more
heavily concentrated than other income, revealing the
loss of vertical equity associated with this design.
IV
The progressivity and redistribution capacity of
the Uruguayan dual tax
The need to maintain a tax burden of about 30% of
gdp means that indirect taxes (15% of gdp in 2005)
and pension contributions (7%) account for a large
share of the tax structure, making it regressive. The
need to temper these adverse effects on equity is
a second reason for introducing a comprehensive,
progressive personal income tax, especially given
that the limited fiscal revenues available19 leave very
18
Broadway (2005) summarizes the following arguments in favour of
reducing the tax on capital income: (i) there is a positive externality
when investment is linked to innovation, according to the studies
available on endogenous growth; (ii) there is a systematic tendency
for saving to be suboptimal, which seems irrational (in practice, it is
possible that individuals are acting strategically, anticipating that the
government or a philanthropist will come to their aid); (iii) taxing
capital income discriminates against households with fluctuating
incomes that use saving as a way of flattening out their consumption.
In theory, taxing capital income at a lower rate is equivalent to
applying different rates to present and future consumption.
19
See Villela, Roca and Barreix (2005).
few resources free for financing redistributive public
social spending, which is the most suitable instrument.
Available fiscal revenue in the country, defined as tax
revenues (30.4% of gdp in 2005) minus “inflexible
obligations”, i.e., social security expenditure (11.4%)
and interest payments on the public debt (4.5%), is
currently 14.6% of gdp, having been as low as 10%
of gdp in 2003.
Some observations should now be made, therefore,
on the progressivity and redistributive effect of the
new dual personal income tax (impuesto a la renta de
las personas físicas—irpf). The figures given in table
2 are the results of a static microsimulation exercise
without behaviour functions, carried out using 2004
microdata from the Continuous Household Survey (ine,
2004). The methodological details of this exercise can
be found in Barreix and Roca (2006).
The average rates for both the personal receipts
tax (irp) and the dual personal income tax (irpf) rise
as we move up the income scale from the poorest to
the wealthiest deciles. This rise is far more pronounced
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table 2
Uruguay: Personal receipts tax (irp) and dual personal income tax (irpf), by decile
Effective average rate
(%)
Decile
Decile
Decile
Decile
Decile
Decile
Decile
Decile
Decile
Decile
irp
1
2
3
4
5
6
7
8
9
10
0.23
0.70
1.05
1.36
1.60
1.84
2.13
2.51
2.89
3.21
Kakwani index
Reynolds-Smolensky index
Transfer from wealthiest 10%
Transfer from wealthiest 20%
Transfer from wealthiest 50%
0.1973
0.0047
0.27%
0.35%
0.24%
Dual irpf
0.10
0.22
0.48
0.91
1.31
1.89
2.73
3.94
6.22
11.23
Proportion of tax’s revenue
paid by each decile (%)
irp
Dual irpf
0.3
1.3
2.4
3.5
4.7
6.4
8.6
12.5
19.1
41.3
0.1
0.2
0.5
1.0
1.7
2.8
4.8
8.5
17.8
62.7
0.3887
0.0222
1.86%
1.99%
1.11%
Source: Barreix and Roca (2006).
in the case of the dual tax, however, something that
is well borne out by the Kakwani index which, unlike
the progression of the average rate, is a comprehensive
indicator of progressivity.20 As table 2 shows, the fact
that the Kakwani index is higher for the irpf (0.3887)
than for the irp (0.1973) shows that the former is more
progressive.
As regards redistribution capacity, this can be
measured using the Reynolds-Smolensky index, a
comprehensive indicator of redistribution capacity
(table 2).21 The index value associated with the dual
tax (0.0222) is higher than that associated with the
20
Kakwani index = quasi-Gini (personal income tax) - Gini (income
prior to fiscal policy). Income prior to fiscal policy, also known as
autonomous income, is income that has not yet been affected by taxes
or public transfers. The quasi-Gini for tax is calculated much like
the Gini for income, but from the tax concentration curve, whence
the semantic distinction. If K > 0, i.e., if the personal income tax
is distributed more inequitably than income prior to fiscal policy,
the effect of tax is to reduce inequality in income distribution and
it is therefore progressive. If K < 0, on the other hand, the tax is
regressive.
21
Reynolds-Smolensky (rs) index = Gini (income prior to fiscal
policy) - Gini (income after personal income tax). If rs > 0, inequality
in income distribution has diminished since the introduction of the
personal income tax and this tax will therefore be progressive. The
opposite holds if rs < 0.
irp (0.0047), meaning that the former causes an
improvement in income distribution of more than 2
points of the Gini coefficient, which is greater than the
half point improvement in the Gini caused by the irp,
allowing the irp to be identified as (quasi) neutral. The
introduction of the dual tax results in a transfer of 2%
of total income (after the irpf) from the richest 20%
of households to the other 80%.
The substantially greater redistributive capacity
of the irpf as against the irp is also seen when the
respective percentages of the tax take from each decile
are compared. While the poorest 40% of households
pay 7.4% of the irp, they will pay 1.7% of the new
irpf. Meanwhile, the richest 20% of the population
pay 60.4% of the irp but will pay 80.5% of the irpf.
While the irp collects 0.87% of gdp, the irpf will
collect about 2.4%.
Following this analysis, we shall conclude with
two observations. First, estimation of the effect of the
tax system in the European Union (15 countries) on
income distribution for 2001 gives an improvement
of 2.5 points in the Gini coefficient. When comparing
this with the dual tax in Uruguay, which, as we have
seen, entails a drop of 2.2 points in this coefficient, it
is important to emphasize two aspects that are striking
in their own right: the higher tax burden entailed by
personal income tax (progressive and redistributive as
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it is) in the European Union, and the large contribution
made by it to the total tax revenues of that bloc. The
redistributive effect of the new dual tax in Uruguay
should therefore not be underestimated.
Second, given that the reduction in indirect
taxation resulting from the tax reform22 will be financed
from the proceeds of the Uruguayan style dual tax,
what matters is the overall effect of the reform on
equity. While the pre-reform tax system was regressive
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(Kakwani index = -0.0088), the post-reform system is
progressive (Kakwani index = 0.0993). Again, while
the pre-reform tax system worsened income distribution
(Reynolds-Smolensky index = -0.0012), the new tax
system clearly improves it (Reynolds-Smolensky
index = 0.0167). In other words, the introduction
of the Uruguayan dual tax makes the tax system as
a whole progressive and redistributive (Barreix and
Roca, 2006).
V
The pillars of taxation in Latin America: the need
to collect income tax
1.
A simple typology of current tax systems
Tax structures are determined essentially by three
factors: (i) the country’s paradigm of insertion in
the international economy; (ii) the level, quality and
sustainability of public spending; (iii) the performance
of the tax administration in a broad sense.23 To establish
a typology of the different tax systems in operation
today, we propose to identify their main pillars (plus
complements), by “main pillars” being meant taxes that
are capable of generating substantial, stable revenues
and are broadly based, as this enhances their neutrality
and elasticity.
This typology is dynamic. Thus, for example,
import taxes were a pillar of taxation after the crisis
of the late 1920s (the Great Depression) in both
developed and underdeveloped countries. At that
time they collected some 25% of tax revenues, but in
today’s open economies their revenue-raising capacity
has diminished.
In our view, there are now three pillars of taxation
and three complements. The three pillars are: (i) income
tax (strictly speaking, the system of taxation on income);
22
Abolition of the cofis (wholesale vat of 3%), reduction of the
basic rate of vat from 23% to 22% and of the lower rate from
14% to 10%.
23
The term “tax administration” is used here in a broader sense than
the traditional one, referring to what we may call a “system of tax
institutions”. This system encompasses not only the internal revenue
agency and customs but also other institutions ranging from land
and property registries to the judiciary.
(ii) general consumption taxes (vat and other retail
taxes); (iii) pension contributions (with the variant of
private-sector and mixed systems). The complements,
meanwhile, are: (i) taxes on renewable and non-renewable
natural resources; (ii) taxes on property (particularly
real estate), personal assets and the transmission of
wealth (mainly inheritance taxes); and (iii) specific
consumption taxes.
2.Strengthening the pillars of taxation
To guide our analysis, we may compare the main taxes
underpinning fiscal sustainability in Latin America on
the one hand and the Organisation for Economic Cooperation and Development (oecd) on the other. Table
3 shows that the greatest differences between these
two groups of countries are in the areas of personal
income tax and social security contributions; vat and
corporation tax, conversely, look fairly alike, despite
the large disparities in development and income levels
between the two groups.
We shall not go into the considerations that, in
our view, rule out any prospect of the taxes we have
called “complements” becoming pillars of the tax
system in Latin America. We shall merely note that
natural resource taxes are highly variable (Jiménez and
Tromben, 2006), there is a worldwide trend towards the
abolition of corporate asset taxes and inheritance taxes,
and selective taxes are severely constrained by the scope
for smuggling and/or are regressive (the exception
being vehicle fuel taxes). And while Latin America
still has work to do in developing taxes on property,
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table 3
Organisation for Economic Co-operation
and Development (oecd) and Latin America:
Pillars of taxation, 2004
(Percentages of gross domestic product)
oecd
Tax revenueb
Value added tax (vat)c
Income tax
Corporation tax
Personal income tax
Social security contributionsd
35.9
6.7
12.5
3.4
9.1
9.3
Latin Americaa
20.2
5.8
3.8
2.6
1.2
2.8
Source: Organization for Economic Co-operation and Development
( oecd ), Economic Commission for Latin America and the
Caribbean (eclac), Inter-American Development Bank (idb) and
International Monetary Fund (imf).
a
Includes oil revenues in Colombia, Ecuador, Mexico and the
Bolivarian Republic of Venezuela, minerals in Bolivia and Chile
and hydroelectricity in Paraguay.
b
Includes social security (pensions).
c
Includes the tax on goods movements and service provision
(icsm) in Brazil.
d
Includes contributions to public systems.
particularly real estate and vehicles, the amount these
can raise is limited (1% or 2% of gdp).
3.
Payroll taxes to finance pensions have no
future
We believe that the revenue-raising potential of payroll
taxes to finance pensions is almost nil in Latin America.
In open, competitive economies with high and rising
rates of chronic unemployment (around 10% on
average), the non-capitalizable element of pension
contributions is just another charge on labour that bears
down on wages and/or employment.
In the first place, if the results of the HeckscherOhlin theorem are borne out by trade liberalization,
the prices of tradable inputs will tend to equalize and
countries will export goods that use their abundant
factor intensively and import goods that use their
scarce factor intensively. At the same time, the StolperSamuelson theorem states that a rise in the relative
price of a good will lead to a rise in the return to that
factor which is used most intensively in the production
of the good and to a fall in the return to the other
factor. For the Latin American countries, the result in
practice is growth in the commodity sector (agricultural
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commodities and non-renewable natural resources) and
a partial decline in the industrial sector, dominated by
the Asian countries where labour is abundant.24 The
economic sectors that have traditionally generated jobs
in the region, namely industry and formal commerce,
have seen their share in the composition of gdp decline
in the last 35 years (4.2% and 6.6%, respectively).
The factor that has gained is capital (capital-intensive
primary sectors) and returns on labour have experienced
a relative decline.
At the same time, there is a tendency to replace
labour by technology ( imf , 2007). In particular,
advances in agriculture, information technology and
robotics are reducing the number of unskilled workers.
It is clear that workers in Latin America, a region
where public education spending is low (less than 3%
of gdp) and investment in research and development
is paltry (0.3% on average), will find it harder and
harder to compete for work and wages with more
highly skilled workers not only in the oecd countries
but also in the new market economies of the former
Soviet bloc and India.
In view of this, and of the past and potential crises
in the unfunded pension systems of certain countries,
the (public) principle of (intergenerational) solidarity
has been supplemented by a (private) system of strict
equivalence between contributions and pension levels
(individual funded system), with a number of countries
opting for mixed or parallel systems. Although pension
system pressure is not yet a problem in some Latin
American countries whose population pyramid still has
a wide base, there must be concerns about the future.
The fact is that, over the course of two generations
(1950-1955 period compared to 2000-2005), the gross
birth rate has fallen by almost 50% (from 42 to 21 per
1,000 inhabitants) while life expectancy at birth has
risen by 38% (from 51.8 to 71.9). The result is that
the labour component in the composition of taxpayers
will diminish while at the same time the proportion
of potential recipients (pensioners) will increase
exponentially, and this will be compounded by the
burden of pension system debt and the (gross) financial
debt of the non-financial public sector, estimated to
average 86% and 48% of gdp, respectively.
24
And which apply policies such as managed exchange rates and
investment incentives, among others, and have lower levels of
unionization.
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To sum up, the tendencies referred to make it very
unlikely that payroll taxes to finance pensions can attain
the level of revenue required to make them a pillar of
the fiscal structure.
4.
vat: good at raising revenue, bad at
distributing it
In Latin America, quite a number of attempts have
been made to use exemptions and differential rates to
give vat an income redistribution role. In our view, the
outcome of these efforts has not only been marginal
but has resulted in high tax expenditure that favours
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the wealthiest deciles, wasting resources that could
indeed have had redistributive effects if targeted on
public social spending.
The case of Mexico is very revealing in this respect
(table 4). Mexico’s vat is progressive even when income
is taken as an indicator of well-being. In the richest
deciles, for example, 60% of spending is subject to
the general rate and just 10% to the zero rate, while
for the poorest deciles these proportions are 41% and
38%, respectively. Although the tax expenditure implicit
in this design is 2% of gdp, however, its redistributive
capacity is slight: after tax there is a transfer of just
0.15% of total income from the richest 50% to the
table 4
Latin America (nine countries): Equity of value added tax
(By per capita income decile)
Colombia Ecuador Argentina Uruguay
A. Progressivity
Effective tax/income rate (%)
Poorest decile
Second poorest decile
Mexico Honduras Costa Rica Guatemala
Panama
10.8
8.6
4.6
4.2
11.7
9.2
9.5
8.9
1.1
1.6
12.7
3.7
5.4
4.2
20.2
9.1
4.6
2.2
Second wealthiest decile
Wealthiest decile
5.4
4.7
4.9
5.2
7.8
6.8
6.8
6.1
3.6
3.7
2.7
2.3
3.5
3.0
5.4
4.9
1.7
1.7
Gini income inequality
coefficient, prior to vat
0.537
0.408
0.549
0.317
0.433
0.570
0.577
0.596
0.636
Quasi-Gini after vat
0.469
0.445
0.507
0.254
0.547
0.480
0.489
0.460
0.533
-0.068
0.038
-0.042
-0.063
0.113
-0.090
-0.089
-0.136
-0.104
0.541
0.406
0.555
0.322
0.430
0.575
0.580
0.604
0.638
Transfer from poorest 50% to
wealthiest 50% (or from
wealthiest 50% to poorest 50%)
-0.20%
0.09%
-0.30%
-0.25%
0.15%
-0.25%
-0.16%
-0.40%
-0.09%
Losers
1 to 6 9 and 10
1 to 9
and 9
1 to 6 and 8
8 to 10
1 to 8
1 to 9
1 to 9
C. Who pays the tax
Poorest 40%
Wealthiest 20%
Wealthiest 20%/poorest 40% 14%
55%
4.0 14%
52%
3.7 11%
62%
5.4 24%
35%
1.5
8%
59%
7.4
13%
54%
4.2
12%
56%
4.8
15%
53%
3.5
6.0
2.6
1.6
3.2
2.0
2.3
Kakwani index (if < 0 =>
regressive; if > 0 => progressive)
B. Redistribution
Gini income inequality
coefficient, after vat
D. Tax expenditure
As % of gdp
…
2.4
1 to 7
10%
58%
5.6
…
Source: For equity: in Colombia, Zapata and Ariza (2006); in Ecuador, Arteta (2006); in Argentina, Gómez Sabaini, Santieri and Rossignolo
(2002); in Uruguay, Barreix and Roca (2006); in Mexico, Ministry of Finance and Public Credit (2004); in Honduras, Garriga (2007);
in Costa Rica, Trejos (2007); in Guatemala, icefi (2007); in Panama, Rodríguez (2007), Barreix and Roca (2007). For tax expenditure:
in Colombia, 1999 data, Simonit (2002); in Ecuador, 1999 data, Roca and Vallarino (2003); in Argentina, 2001 data, Simonit (2002); in
Uruguay, 1999 data, Rossa and Roca (2001); in Mexico, Tax Administration Service (2005); in Honduras, Gómez Sabaini (2006); and in
Guatemala, DevTech (2002).
Strengthening a fiscal pillar: the Uruguayan dual income tax • Alberto Barreix and Jerónimo Roca
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poorest 50%. By contrast, personal income tax, which
collects about 2.4% of gdp , has a redistributive
effect more than 10 times as great and the “ProgresaOportunidades” programme of public spending targeted
on poverty alleviation achieves a similar redistributive
effect to vat but at one eighth of the fiscal cost.
Furthermore, the “progressivity without redistribution”
of vat has a cost: 54% of the benefits of the zero rate
go to the highest-income decile and just 3.5% to the
poorest. It seems clear, for one thing, that abolishing
this benefit would substantially increase revenues, so
that the losers could if necessary be compensated out
of public spending, preventing any major deterioration
in equity.
Section A of table 4 shows that the regressive effect
of vat is moderate, section B that its redistributive effect
is almost nil despite strong revenues, and section C that
because consumption is concentrated in the highest
deciles, exemptions have a very high fiscal cost.
In summary, vat is a revenue-raising tax and not
a redistributive one, which means that it should tend to
the greatest neutrality and simplicity possible to ensure
compliance and thus establish itself firmly as a pillar
of the system, while it needs to be recognized that
personal income tax excels all others in its redistributive
potential.
5.Income tax: the great shortfall
As was shown in table 3 earlier, the amount raised
by corporation tax in Latin America is close to the
oecd average: 2.6% and 3.4% of gdp, respectively.
As already pointed out, however, revenue from income
tax on sole traders is included in this category in
Latin America, while in the developed countries it is
categorized as personal income tax.
Where corporation tax is concerned, it is a fact
that capital mobility has not only brought down nominal
rates around the world, but forms of special treatment
designed to attract capital have proliferated and these,
in combination with tax planning, have eroded the tax
base. Economic liberalization and the integration of
markets have produced some structural changes in the
tax that are not going to be reversed. For example, in
1918 corporation tax in the United States yielded four
times as much as personal income tax, which only
affected the wealthiest; around 1950 both taxes yielded
the same; but by 1980 physical persons were paying
about four times as much as businesses, and this remains
the case to this day. What we seem to be looking at is
a global phenomenon, with relatively weak and non-
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137
cooperating national States in a very poor position to
tax corporate income.
By contrast, personal income tax in Latin America
raises barely 1.2% of gdp on average (see table 3 above).
This tax, which is predominantly synthetic, riddled with
exemptions and “dualized” in an inconsistent way to
the benefit of capital income, is highly progressive
but has a very limited capacity for redistribution, as
the low revenues yielded by it would indicate. For
example, only in Mexico does it bring down the Gini
income inequality coefficient by more than 1 point of
that coefficient (table 5).
When we are dealing with countries where the
income share of the richest 20% is more than five
times that of the poorest 40%, it seems clear that a
reformulation of the tax, taking into consideration
the new forms discussed here, would raise more
revenue and thus allow greater redistribution. Indeed,
in Uruguay, where income distribution is relatively
equitable by regional standards (the share of the
richest 20% is 3.6 times that of the poorest 40%),
it is estimated that the new dual tax will reduce the
Gini coefficient by 2.2%, in line with the developed
countries (the transfer from the richest 10% is almost
2% of total income).
It is clear, then, that the great taxation shortfall
in the region derives from the situation with personal
income tax. It is only fair to acknowledge that it will be
impossible to attain the levels of revenue raised by the
mass taxes in the developed countries, where average per
capita income at purchasing power parity is four times
that of Latin America, while financial income is almost
eight times as high. It must be realized, however, that
our proposal for Uruguay concentrates the tax burden
on the two wealthiest deciles, making it appropriate for
a region where, as we have pointed out, the richest 20%
across Latin America receive some 60% of total income
while the poorest 40% receive an average of barely more
than 10%. Since open regionalism was implemented
in the early 1990s, furthermore, this average ratio of
5.5 to 1 has remained unchanged, even as income has
increased by almost 60%.
As a corollary to the considerations set out in this
section, there is a vital need for efficient collection of
the revenue from the income tax system, especially the
personal income component. This component is essential
not just as a revenue-raising pillar with the potential for
growth to finance ever-increasing physical and social
infrastructure needs, but also as the tax with the greatest
redistributive capacity. That is a crucial consideration in
a region where the world’s longest-standing and acutest
Strengthening a fiscal pillar: the Uruguayan dual income tax • Alberto Barreix and Jerónimo Roca
138
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table 5
Latin America (10 countries): The equity of personal income taxa
Uruguay Colombia Ecuador Peru
B.R. of Honduras Costa Rica Guatemala Panama Mexico
Venezuela
(2004)
(2003)
(2003) (2000) (2003)
(2004)
(2004)
(2000)
(2003) (2003)
Gini income inequality
coefficient prior to the tax
37.6
53.7
40.8
53.5
42.3
56.9
60.2
59.6
63.6
43.3
Gini coefficient after the tax
35.4
53.4
40.3
53.5
42.1
56.4
59.4
59.5
63.1
39.6
Change in Gini coefficient
2.22
0.30
0.45
0.03
0.19
0.50
0.74
0.11
0.53
3.71
Wealthiest decile: % of
income prior to the tax
30.00
44.5
29.9
41.2
41.9
45.1
49.4
49.3
51.3
33.1
Wealthiest decile: % of
income after the tax
28.20
43.7
29.4
41.1
41.7
44.4
48.7
49.2
50.1
29.7
Change
-1.80
-0.80
-0.50
-0.10
-0.20
-0.76
-0.68
-0.13
-1.18
-3.40
2.4
1.2
1.2
0.4
1.3
1.3
0.4
2.0
2.4
Revenue from the tax,
2004 (% of gdp)
…
Source: Uruguay, Barreix and Roca (2006); Colombia, Zapata and Ariza (2006); Ecuador, Arteta (2006); Peru, Haughton (2006); Bolivarian
Republic of Venezuela, García and Salvato (2006); Honduras, Garriga (2007); Costa Rica, Trejos (2007); Guatemala, icefi (2007); Panama,
Rodríguez (2007); Mexico, Ministry of Finance and Public Credit (2004) and Barreix and Roca (2007).
a
The years in brackets below the names of the countries are those of the surveys used to prepare the estimates.
income inequality coexists with a high level of poverty.25
Personal income tax, then, can be an important element
of social cohesion in Latin America, since inequality
prior to fiscal policy is worsening both in developing
countries and in those of the oecd. Tax revenue raised
from the highest deciles can be used to finance targeted
spending on the lowest, thereby providing opportunities
for the least privileged. At the same time, payment of
such an individual tax not only strengthens taxpayers’
relationship with the State but legitimizes their demands
for better public services.
To sum up, in the medium term the taxation basis
for fiscal sustainability in Latin America will have just
two pillars: vat and the system for taxing income.
To show responsibility, therefore, the region ought
to renew the mainstays of its tax system, particularly
income tax, during the very favourable upturn stage
of the cycle.
(Original: Spanish)
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